Monday Q&A – and An Update on Our Survey

This week’s main question comes from dhannum, who asked what our tests are for the defensive and enterprising investors (something that I will add to the “Our Methods” page soon).  Our tests come from Benjamin Graham’s The Intelligent Investor, chapters 14 and 15.  We’ve made some minor updates to the criteria that he originally provided.  For example, we’ve increased the market cap.  Here are our tests in more detail:

Defensive Investor – must pass at least 6 out of the 7.

1. Adequate Size of the Enterprise – the market cap must be greater than $2 billion.
2. A Sufficiently Strong Financial Condition – the current ratio (current assets divided by current liabilites) must be greater than 2.  For companies that don’t carry current assets and liabilities – mainly banks and insurance companies – we use Total Assets and Total Debt here.
3. Earnings Stability – Consistently positive earnings per share for the last ten years. 
4. Dividend Record – Has consistently paid a dividend for at least ten years.
5. Earnings Growth – Earnings per share is at least 33% greater than it was 10 years ago (based on 3 year averages from the first 3 years of the period versus the last 3 years of the period).
6. Moderate PEmg Ratio – PEmg (our version of the PE ratio, based on a weighted average of earnings over the last 5 years) is less than 20.
7. Moderate Price to Assets Ratio – Price to Book ratio is less than 2.5 or price to book times the PEmg is less than 50.

Enterprising Investor – must pass 4 out of the 5.

1. Sufficiently Strong Financial Condition – Current Ratio must be greater than 1.5.
2. Sufficiently Strong Financial Condition (continued) – Debt divided by net current assets (current assets less current liabilities) must be less than 1.1.
3. Earnings Stability – Consistently positive earnings per share for the last five years.
4. Dividend Record – Must currently pay a dividend.
5. Earnings growth – EPSmg must be greater than it was five years ago.

I hope that makes some things a little clearer for many of you.

Also, last week we posted a very short survey (only 5 questions!) for our readers to complete.  To date, we’ve received 21 responses.  Though it has been extremely helpful, I’d like to see more as that would lower our margin of error and help us determine the best path to pursue with our site going into the future.  Please take a couple of minutes to complete our survey and help us out.